By Neil Holmes
Starting a business? What is it going to be? Not voiceovers or copywriting or music scheduling, but a sole proprietorship, partnership, or corporation. Here’s a look at the different forms of business. (Remember, laws vary from state to state, so talk to a lawyer and accountant about the advantages of each for your own situation.)
Sole Proprietorship: Probably the simplest. It can be operated under the name of the owner, is the least expensive to form, and is relatively simple to establish and operate. You should file a DBA (Doing Business As) certificate with your county, and open a separate bank account for the business. Profit and loss of a Sole Proprietorship is “flow through.” Income or loss is reported with the owner’s other income on their tax return. All assets are owned by the proprietor, and you will have complete control over the business. Of course that means everything is on your shoulders, so make sure you have adequate insurance on equipment, liability, your health and life. When the sole proprietor dies, so does the proprietorship. (And when the owner is on vacation, the business may be on vacation, and not billing.
General Partnership: Two or more people who operate a business and share profits (or loss). While most states do not require a partnership agreement, get one! A handshake deal may work for a week or two, but in the end, you need to spell out who is responsible for every aspect of the business including how you’ll divide profits and who adds cash to keep the business running. The agreement should include how decisions will be made, how the partnership will pay bills, buy supplies, hire employees, how the agreement can be terminated, and what happens at the death, disability or retirement of a partner. Cover your bases up front. All members of the partnership will be better off if everyone operates from the same playbook, and not from “understandings.” As with a Sole Proprietorship, you should get a DBA from the county and a separate bank account. General partners are “jointly and severally” liable, so insurance is especially important because your business and personal assets are at risk to satisfy business debts. As for taxes, the partnership is not a taxable entity. The partnership files a tax return, but the partnership income or loss is passed through to the partner’s individual return, and is taxed at the individual partner’s rate. You are taxed whether the income is actually distributed or not. With a General Partnership, there are no restrictions on who may be a partner. You’ll have a partner to bounce ideas off and share the load. You may even get some vacation time, as your partner can cover your absence.
Limited Partnership: This is a partnership with two forms of owners - general partners and limited partners. General partners operate as above and have control of the business. A limited partner has no say in the operation of the business, they have only an investment interest (similar to preferred stock). A limited partnership is more costly to form, as a certificate of formation may be required by your state, and a written partnership agreement is required. Liability passes through to the individual general partners, while the limited partner is only liable to the capital invested. Profits and losses pass through to general partners.
Limited Liability Company (LLC): In its simplest form, a LLC can be relatively inexpensive to operate. It runs similarly to a general partnership, but there can be less liability. Generally, a member of a LLC is liable to the extent of his or her capital contribution, if the member personally guaranteed any obligations of the business, or if the member is personally responsible for the act that is the basis for a claim. In short, members have corporate like protection, and personal assets are generally protected. Not all states allow a LLC, and not all states require a written agreement, but it is highly recommended. Transfer of ownership, daily operations control and other business functions should be laid out in the operating agreement. Most states require a certificate of formation, and may require publication in specified newspapers. A LLC can be taxed as either a partnership or a corporation. The greatest benefit of a LLC: the corporate advantage of limitation of liability with the tax advantages of a partnership, and membership interests are freely transferable.
Corporations: Most expensive to start, because of the legal and filing fees, and the cost of corporate tax return preparation is higher. A shareholder agreement is not generally required, but is recommended. Shareholders then elect a board of directors to oversee the company, and the board elects or appoints officers to handle daily operations. Each shareholder is generally not personally liable for the business debts of the corporation. Shareholders, officers and directors must meet at certain intervals, and maintain records of meetings and resolutions. Shares are generally freely transferable, subject to the shareholder agreement. A “C” Corporation is taxed on net income, then the shareholders taxed on distributed dividends (this is often called the “Double tax,” and is one of the items President Bush wants to eliminate). An “S” corporation is usually not taxed by the federal government, though there will usually be a state tax. “S” corporation shareholders are taxed on their share of net income.
This is just the tip of the iceberg, but should help give you some background. Consult a lawyer or accountant in your county to make sure you get the proper papers filed. When starting your own business, it is more cost effective to do it right, than do it over (and pay IRS and other penalties).